One of the first questions most buyers ask me is "How Much Are Closing Costs?".  And I've heard many real estate and mortgage professionals make general statements that closing costs are "X percent of the sales price".   Quite often, borrowers plan to ask the seller to pay closing costs without even knowing how much they will cost.  Or they make assumptions of how much they will be based on these misguided and oversimplistic generalizations.   

The truth is that the dollar amount of closing costs as well as their percentage relative to the sales price of a property depends entirely on two things:

• The sales price of the property, and
• How the borrower chooses to structure their loan. 

I know.  That last one is a bit confusing so i'm going to address the sales price/loan amount issue first and then tweak the first example to illustrate the second point. 

So here's a good example of my first point (and remember, these are average figures in TEXAS, which is considered one of the higher cost states for closing costs).  Here are three scenarios with different loan amounts.  For the sake of simplicity, let's assume that all are putting 20% down and all borrowers choose to pay a 1% origination fee:

Since many of the closing costs are the same regardless of the sales price and loan amount, the percentage of closing costs relative to the sales price is different in each scenario.  For example, a survey is usually $400 regardless of the price of the home (unless, of course, the lot is oversized).  The title company escrow fee is generally the same as well, around $250 on average.  The appraisal MIGHT be an extra $100 IF the property is over a certain amount of square feet, but the difference would be relatively insignificant.   

So it's fair to say that THE PERCENTAGE OF CLOSING COSTS RELATIVE TO THE SALES PRICE IS GENERALLY HIGHER ON LOWER PRICED HOMES AND LOWER ON HIGHER PRICED HOMES since the majority of closing costs are fixed regardless of sales price.  

So what about the second variable: Borrower options?  That can make a major difference as well.  Let's tweak the OPTIONS on our first example and assume that:

Buyer A chooses to pay two points to buy their rate down and also chooses to include escrows in their mortgage payment.

Buyer B chooses to pay one point and get a slightly higher rate than Buyer A, but decides to waive escrows. 

Buyer C chooses to pay a higher rate than both Buyer A and B instead of paying any points (an option on many but not all loans) and also chooses to waive escrows.

Now there's a SUBSTANTIAL difference in the percentage of closing costs relative to the sales price.  Buyer A must pay over 5% of the sales price in closing costs versus the million dollar buyer who is barely paying 1%.  (Notice the referenced options are highlighted in bold.)

So simply stating that closing costs represent a certain fixed percentage of the sales price (I've heard many people assume it's always 3%) is greatly oversimplifying reality.   The sales price and borrower options will ultimately determine the amount of closing costs, as well as the percentage relative to the sales price.  If Buyer B or C asked the seller to pay 3% towards closing costs in this above scenario, they would be leaving a substantial amount of money on the table and the deal would have to be restructured (which might ruffle some feathers and/or delay closing). 

This is yet another reason why a thorough pre-approval AND consultation with a lender must take place prior to serious house hunting, ESPECIALLY IF the buyer plans to ask the seller to pay for closing costs.  Many borrowers assume they can work these details out AFTER THE FACT, but that often causes a huge mess that takes ten times longer to clean up than if it had just been done right the first time.   Also, many buyers do not realize they have options on paying points, so many assume they just have to take whatever deal is offered to them and there's no flexibility.  While this is not always an option on every loan scenario, most people buying owner occupied properties with good credit do have the option of paying points to get a lower rate or not paying points and getting a higher than par rate.  There are advantages and disadvantages to paying points that I will discuss in a future blog.